Hedging Transition Risks in Europe: A Comparative Study of ESG Derivatives and Stock-Based Hedge Portfolios

Abstract

This thesis examines the effectiveness of four hedging strategies against climate transition risk in the European equity market between 2015 and 2024. The strategies include carbon futures, ESG index futures, and two equitybased portfolios constructed using firm-level sensitivity to climate transition shocks. A total of 111 transition risk events are identified using a transition risk index, and performance is evaluated during [-2, +2] event windows based on average return, Sharpe ratio, and conditional beta relative to the STOXX Europe 600. The findings show that ESG and carbon-linked instruments offer limited protection during climate risk events. In contrast, a dynamically constructed Alekseev-style portfolio, developed as part of this thesis by the author, achieves negative conditional beta and strong returns, demonstrating superior hedging performance. The results highlight the limitations of conventional ESG products and support the use of customised, empirically grounded strategies for managing transition risk.